Educational Articles

Using Value Line Options for Your Covered Calls

Lawrence D. Cavanagh
| December 22, 2009

We believe that The Value Line Daily Options Survey offers the best tools in the business for the covered call investor. These tools include our unique set of covered call data, our covered call ranking system (our rank 1s have strongly outperformed the market), our daily top-200 Recommended Covered Calls, our flexible Option Screener and our Model Covered Call Portfolio. This week, we review these tools.

Covered Calls: A Quick Review

You create a covered call by buying shares of stock and writing calls on these shares. The premium you receive from writing the calls is your compensation for taking on the obligation to sell the stock at the strike price if the call is exercised. Depending on the strike price of the call, a covered call can be bullish (strike price above the stock price), neutral (strike price equal, or close to, the stock price) or defensive (strike price below stock price). As such, covered calls can provide varying degrees of upside potential, premium income and downside protection.

In Figure 1 below, we compare three covered calls on Priceline (PCLN) with the stock at $90.30. The out-of-the-money June $105 strike call offers a maximum profit (column heading MX) of 22%, downside protection of 4% (heading PT) and a return of 19% p.a. The at-the-money June $90 call offers a smaller maximum profit of 12%, but higher return of 45% p.a. and greater downside protection of 11%. The in-the-money June $75 call offers a maximum profit of only 5% and a per-annum return of 20%. However, this in-the-money call offers downside protection of 21%, since the stock would have to fall by the full $19.40 amount of the premium before the investor would lose money. For a description of how we make these various calculations, see “Covered Calls, Doing the Math” (Ot071126.Pdf) in our Reports Archive.

Our Covered Call Ranks and Track Record

We rank covered calls based on a combination of the common stock rank and of our option model’s evaluation of the call itself. A rank 1 covered call (best for covered call writing) is likely to be an overvalued call that is based on a rank 1 or rank 2 stock. Looking again at Figure 1 above, you may notice that all these calls have a covered call rank of 1 as shown in the last column (marked CC/MP), that they are all overvalued calls, and are based on a rank 1 stock (Priceline, PCLN). At present, there are about 5,500 rank 1 covered calls listed in our service.

How well have our covered call ranks worked. Year-to-date, our rank 1 covered calls are up 2.7%, while the S&P has fallen by 4.3%. Cumulatively over the past 7 ¾ years, our ranked 1 covered calls have generated an average annual return of 9.9% versus a 1.3% average return for the S&P 500 over the same period.

Our Online Covered Call Information: We provide a wealth of useful data and analysis for the covered call writer. In addition to the calculations shown in Figure 1, we also allow subscribers to view our detailed Options Profile as shown in Figure 2 below.

Additional information includes the actual breakeven price of the covered call (C’vd B/E, here $80.57), our model’s estimated premium (here $6.89 versus a bid price of $10.30), the daily Theta or return on one covered call ($5.47 in this example) and the Delta of the option (58 in this example).

Our 200 Recommended Covered Calls: Twice a day, we update a list of our model’s 200 best scoring rank 1 calls for covered call writing. These top-200 calls also meet the following requirements; above average liquidity, a delta of between 20 and 80 (assuring that no options are too deep in-the-money or too far out-of-the-money) and no more than five calls per underlying stock. As of April 15, 2009, our top 200 covered call list included covered calls on 75 different rank 1 common stocks, including CACI Int'l (CACI), Compass Minerals (CMP) and Pre-Paid Legal Services (PPD).

Our Option Screener: Subscribers quickly find that our online Option Screener is one of the best tools in the business for selecting covered calls. With this screener, you can set your desired criteria, including common and covered call rank, expiration, return, and downside protection. You then get a list of the best covered calls that meet these criteria. One nice feature of our screener is that it allows you to enter a list of stocks you may be tracking (or already own) to find the best covered calls on these stocks. Note: If you are using the Value Line Investment Survey’s stock screener, you can automatically send a list of selected stocks to our Options Screener to find the best covered calls on them.

Our Model Covered Call Portfolio: Lastly to help investors get started with covered calls, we post a Model Portfolio of covered calls at our website. This portfolio, which we update weekly, consists of 20 different covered call positions. Since the Model Portfolio’s inception in February 2007, it has beaten the S&P 500 by a wide margin. In Figure 3 below, we show a selection of some of the covered calls currently in this model portfolio.